High net worth individuals must be concerned about taxes on large asset transfers. We have an estate tax in the United States, and there is also a gift tax. In the state of New York there is an estate tax on the state level as well, but we will discuss that in a different post.
The gift tax and the estate tax are unified. The unified exclusion or credit is $5.25 million dollars. This is the amount of money that you can bequeath, or gift to others while you are alive, before these transfers are exposed to taxation.
Are there any types of tax advantages that can be realized by giving gifts while you are still alive? In general the answer is no, because the whole purpose of the gift tax is to remove any advantages.
The federal estate tax was enacted in 1916. At that time there was no gift tax. You didn’t have to be a PhD mathematician to put two and two together and come to the conclusion that you could give gifts to your heirs while you are living to avoid the estate tax.
As a result, a gift tax was enacted in 1924 to prevent wealthy people from giving away their assets while they were still living to avoid the estate tax. It was repealed in 1926, and reinstated 1932. It became unified with the federal estate tax in 1976.
Because the gift tax carries the same 40 percent rate, there is really no benefit to be gained by giving gifts while you are alive to avoid the estate tax.
There is however a caveat to this. It is true that there is no benefit if you transfer assets using the unified lifetime gift/estate tax exclusion to give gifts. However, there is another exclusion that can be utilized to give tax-free gifts.
Annual Gift Tax Exclusion
Every year you may give gifts totaling any amount of money to an unlimited number of people free of the gift tax. These gifts would not reduce the amount of your available unified exclusion.
In 2013 the amount of this annual gift tax exclusion is $14,000.
If you are exposed to federal transfer taxes you would definitely want to consider giving tax-free gifts while you are alive using this exclusion. By doing so you are transferring assets to people who are on your inheritance list in a tax-free manner, but you are not using any of your unified exclusion.
Because this is a per-person exclusion, you and your spouse could give as much as $28,000 annually to any number of people. If you do this over an extended period of time, you could effectively transfer a significant sum of money absolutely free of federal transfer taxes.